10 Ways to Avoid Market Volatility

Follow these tips to prepare for market turbulence

Market volatility, whether in the stock market or the bond market, makes investors anxious. Or maybe I should say downside market volatility makes investors anxious, because most investors I speak with don’t often get too concerned with market volatility to the upside — when the markets are bounding higher and their portfolios are hitting values they’ve never seen before. Queasiness tends to set in when the markets are rocking and rolling and — overall — losing ground.

The market volatility-tracking index for the S&P 500 — the VIX, or “fear index” — has been almost too quiet for 2013. Consider that during the past nine months, the VIX has averaged just 14.23, the lowest average since 2006, and two-thirds the average level of the past two-plus decades.

I can’t tell you whether this volatility will ultimately lead to higher or lower stock prices, but I can tell you we’ll probably see both. With that in mind, I thought I’d offer up my list of the 10 best ways to prepare for and deal with increasing market volatility.

1. Turn off the boob tube and stop listening to the talking heads.They’re more interested in bumping up their media ratings points than providing solid investment advice. So far this year, I’ve heard or read the “experts” predicting everything from a 44% drop for the S&P 500 (the index is up nearly 20% year-to-date) to a full-blown bond market crash reminiscent of 2008.

2. Make sure you’ve really diversified your portfolio with big slugs of domestic stocks and at least a few foreign equities. Already have lots of domestic funds? Try Vanguard International Growth Fund (VWIGX). And don’t forget that you should also own some bond funds — yes, bond funds — for their shock-absorbing characteristics. Cash also works nicely as a stabilizer, but the yields are almost non-existent.

3. Don’t time the market. Ha, I love the annual feast of articles on “Sell in May,” or the pundits who’ve always got you selling one week and buying the next so that no matter what the markets do they can point to one piece of advice that was “spot on.” Don’t believe a word of it. You can’t sell out of the market before it goes down and get back in before it goes back up. Market-timing is a fool’s game. Not only will you have to pay taxes on any gains you cash out of taxable accounts, but then you’ve got to decide when to get back in.

4. If you’ve got some cash, put it to work now, not when you’re assured the markets are going up and everything looks perfectly calm and safe. You were saving it for a rainy day? Well, it’s not pouring like it was in 2008, but valuations aren’t at record levels, either. Besides, if you’re an investor and not a market-timer, then you have a long-term perspective and should be stashing away as much money as you can in the best of Vanguard’s funds.

5. Reduce portfolio volatility if you’re sleepless. Not everyone is made of the sternest stuff. If you’ve been stressed by the congressional posturing, Syria, or the boob-tube boobs that you can’t seem to ignore, and you’re lying awake worrying about it, then maybe it’s time to take some risk out of your portfolio permanently. To do that, consider trimming stock funds and adding to your short-term bond or cash positions. I like Vanguard Short-Term Investment-Grade Fund (VFSTX), Vanguard Limited-Term Tax-Exempt (VMLTX) and Vanguard Short-Term Tax-Exempt (VWSTX) for almost worry-free risk reduction. That said, don’t overdo it. You need to be able to handle some short-term pain if you’re going to earn good long-term gains.

6. Sell your long-term bond funds, be cautious with Inflation-Protected Securities,and consider a high-yield fund like Fidelity High Income (SPHIX). Junk bond yields like SPHIX’s 5.09% are a nice pickup over straight bond funds, and with the economy in decent shape, defaults have remained super low.

7. Make sure you aren’t overweighting small-cap stocks. The best values remain among stocks in the large-cap arena right now. I’m partial to the PRIMECAP Management team. If you can add to positions in its Vanguard funds, or better yet, can buy shares in the PRIMECAP Odyssey funds, do so. Also, a fund like Vanguard Dividend Growth gives you exposure to big U.S. companies with strong balance sheets.

8. Turn a skeptical eye toward the ever-changing allocations in target-date funds. Target-date funds are low risk, and low-reward, and not really worth your time if you’re willing to do the research to get yourself a better return on your money. Changing allocations in funds like Vanguard’s LifeStrategy, Target Retirement and Managed Payout funds are of particular concern. Those foreign bonds that Vanguard injected into the funds at the end of May? They may work out, but my research suggests there’s not a whole lot of bang for that buck. And how are those commodity swaps working out for Managed Payout investors? Not so good.

9. Don’t measure your portfolio performance from its most recent absolute high. This is the error investors make more than just about any other. If you’d known when the absolute high was going to be, you’d have sold out on Aug. 2, the day the Dow hit 15658.36, right? (And if you answer in the affirmative, go back to my market-timing comments.) Markets go up and down. Look at how you’ve done relative to a benchmark like Vanguard Total Stock Market Fund (VTSMX) or, if you’re really conservative, Vanguard Balanced Index Fund (VBINX). If your long-term performance has been solid, stick with your strategy.

10. Stop and smell the roses. Investing is a marathon. Leave the sprinting to those hedge funds that seem to be blowing up daily—including the one run by John Paulson, who bought gold with all his financial crisis winnings. Look where his investors are today. You’ll do just fine with a slow-and-steady approach.